2004 Was the Year of Commodities Stocks

AS THE FINAL DAYS of the calendar wind down, we in the media love to publish year-in-review pieces to bring back memories, both good and bad, of the past 12 months we've spent on this planet.

The financial media has a slightly different agenda &ndash; to justify what has been written, aired and cyber-broadcast &ndash; and see how it measured up to the market itself.

With that in mind, here is a quote from just over a year ago: The year 2004 is more likely to be known as the "year of the commodity" (see Getting Technical, "Commodities Stocks Look Very Strong," December 1, 2003).

We can credit technical analysis for keeping the bull market in commodities stocks in the forefront of investment policy and keeping a lid on the fundamental enthusiasm for equities in general bubbling up from Wall Street one year ago.

Sure, the major indexes are now in new high ground, but for most of the year they were under water. Chart watchers were mercifully out of the market during most of that time and earning the "lofty" money market rate of 1%, but that is better than suffering sleepless nights while you're losing money in stocks.

The top sectors for 2004, according to Industry Monitors, were not surprisingly energy and basic materials. A roaring bull market in crude oil sent the energy sector to a 36% gain for the year through the close last week, vs. a 9% gain for the Standard & Poor's 500 and a 17% advance for the Russell 2000. That made the XLE energy SPDR (S&P depositary receipts) ETF (exchange traded fund) a top investment (see Chart 1).

CHART 1

But the price of crude oil itself has been in decline for well over two months, and while the major trend in energy stocks is still up, the sector clearly has lost its leadership role. What that means is that other sectors are now performing even better and that, in turn, drives home the point that making a single arbitrary slice of time (like, say, 52 weeks) the basis for investment decisions is folly.

In the year to date, energy has been the place to be, but since October, other parts of the market have taken over.

Number two on the performance list with one week to go in 2004 has been basic materials, with an advance of 33%. (This gain included stocks of all capitalizations.) Stocks operating in this area deal in natural resources and basic industrial inputs like gold, base metals, forest products, steel, chemicals and plastics. (For purists, perhaps energy can be added to this group, but most agree that energy warrants its own category.)

The XLB basic materials SPDR was a late bloomer in 2004, breaking out in August, but it has been a steady gainer since that time (see Chart 2). It continues to outperform the broad market, albeit more sedately in recent weeks.

CHART 2

On the other end of the performance scale has been health care, with a net gain of 11%. This has been a sector of extremes: HMOs have risen 38% and various drug subsectors fell by 8% to 18%, but for ETF investors, the XLV health care SPDR is flat for the year (see Chart 3). Thanks to renewed interest in biotech stocks and what still looks like a bear market bounce in big-cap pharmaceuticals, it is on the verge of a breakout as it is now bumping up against the trend line originating at the February 2004 peak in the 30 area. Its relative performance, however, remains dismal.

CHART 3

Number two on the laggard list was technology, with a net gain of 12%. Underperformance, again across all capitalization levels, was the buzzword here, and its poster child was the supposedly market-driving semiconductor group (see Getting Technical, "Chips Are Rising But Still Lagging," December 6).

Many analysts look to this subsector as a barometer for the health of the overall market, yet this year the market went up despite the chip stocks' troubles.

The XLK technology SPDR spent the first eight months of the year in decline before picking itself up in both absolute and relative terms (see Chart 4).

Until earlier this month, this ETF looked as if it was going to finally catch up to others in 52-week high ground, but some poor action in recent weeks scuttled that wish. The trend is still officially up, but this does not seem to be the place for investors to get the best bang for their buck at this time.

CHART 4

Again, looking at an arbitrary 12-month slice of time gives us a good idea of which area has been the best, but we also need to be mindful of changes in relative performance. Looking at leadership over several slices of time can help us see where the rotation is heading. Right now it seems to be moving toward select sections of health care and other consumer staples areas and away from technology.

Will 2005 be the year of the biotech stock? Will commodities-related areas continue to shine? What about financial stocks, which have been mere market performers so far this year, in the new environment of rising interest rates?

These are all good questions, and we'll visit some of them early in 2005. From all of us here at Getting Technical, may your new year be healthy, safe and profitable.

Getting Technical Mailbag: Send your questions on technical analysis to us at online.editors@barrons.com. We'll cover as many as we can, but please remember that we cannot give investment advice.

Michael Kahn writes the daily "Quick Takes Pro" newsletter and a free version of the same at (www.midnighttrader.com). He is the author of two books on technical analysis, most recently Technical Analysis: Plain and Simple, and was Chief Technical Analyst for BridgeNews. He also is on the Board of Directors of the Market Technicians Association (www.mta.org).

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